Protect yourself by making a will for your IRA; further debate on estate taxesBy Ed Slott

NEW YORK (CNNfn) - All IRA owners have choices to make. The problem is they often neglect important decisions or leave them to someone who has little interest in tax planning.

If you, the IRA owner, do not address three important issues, someone else will. And it is more than likely someone else's choice will not be as good for you - and a poor choice could mean the end of your IRA.

There are three key items that IRA owners must address to make sure their IRAs outlive them and grow for their beneficiaries. The three tax choices are the selection of the beneficiary; the choice of life expectancy; and the election of an IRA distribution method. Here we'll cover choosing the beneficiary. In upcoming CNNfn articles we'll address life expectancy and the distribution method.

Selection of Your IRA Beneficiary

You do not have to choose a beneficiary, but if you don't, someone will choose it for you. This is similar to people who don't leave a will. Eventually somebody gets your money, but it may not be the people you would have chosen.

Naming an IRA beneficiary is like having a will for your IRA and may even be more important, especially since IRAs are the major asset of many estates.

Do not think that you have named an IRA beneficiary simply because you have executed a will. IRAs should not pass through your will. They should pass to the person named as your IRA beneficiary on a separate IRA beneficiary designation form. If you neglect to name an IRA beneficiary or your beneficiaries cannot locate your IRA beneficiary form, then your IRA will most likely pass to your estate.

If your IRA does pass to your estate, then it will be distributed according to your will if you have a will. That means that your IRA which should be a non-probate asset, will now become subject to probate and the related legal complications.

Leaving an IRA to your estate also means that it will become subject to any creditors of your estate. Another problem with letting your IRA pass through your estate is that most of whatever is left after erosion from probate and creditors, will be lost to taxes.

An IRA left to your estate will be paid out soon after your death, depending on when you died (before or after your Required Beginning Date after reaching age 70 1/2) and on which distribution method you elected.

But your estate has no life expectancy to use to continue distributions after your death. Here's why. Your estate can be your IRA beneficiary, but not a designated beneficiary. For IRA tax purposes, the beneficiary is the person or entity that will inherit your IRA, but a designated beneficiary can only be a person (and qualifying trusts) with a life expectancy.

The designated beneficiary is the person whose life expectancy is used to determine how long the IRA will live on after the IRA owner dies. Without a designated beneficiary, the IRA will generally be paid out quickly after the IRA owner's death eliminating any chance of further tax deferral.

An IRA owner's estate is the worst possible choice as IRA beneficiary, but becomes the choice when IRA owners do not name a beneficiary. It seems easy enough to do, but many IRAs are lost because a beneficiary was not timely elected.

Name your IRA beneficiary now and keep an acknowledged copy - signed and dated by someone of authority (anyone with a title) at your IRA financial institution - of your IRA beneficiary designation form.

Also name a secondary (or contingent) beneficiary in case your primary beneficiary predeceases you or to create an estate planning path. Let your heirs know where the form is. If they cannot find it and your financial institution has changed, merged or has simply lost the form, then you have no designated beneficiary.

More on the estate tax bill

Wow! I received more than 100 e-mails in response to last week's column on the House bill to repeal estate taxes. And I received most of them within the first few hours after it was posted. This column definitely touched a nerve on both sides of the issue. Most disagreed with my column in opposition to the bill, by about a 7:1 ratio. One thing that was asked in many of the emails is "Ed ...what would youdo?"

Fair enough. Here is my plan.

I am no fan of the estate tax on most estates, but I do not think estate tax relief should begin with the ultra-wealthy with no relief for the majority of all taxpayers. Tax reform should begin by benefiting the greatest number of taxpayers, not with a select few.

My plan would be to raise the exemption immediately (currently at $675,000 and set to reach $1 million in 2006), to $2.5 million per person. The exemption should not be phased in. It should start in 2001. This would exempt over 99 percent of individuals' estates from estate tax, including those smaller estates that would have been taxed under the House bill waiting for the phase-in to apply, while larger estates were protected. Under my plan, a married couple would have up to $5 million protected from estate taxes immediately.

Estates of up to $5 million would also receive the full step-up in basis even though the estate would not be large enough to be subject to an estate tax, similar to how step-up is currently treated. Smaller estates (up to the $2.5 million per person or $5 million per married couple) should not lose the step-up, while larger estates pay no estate tax.

I would also completely repeal the Generation Skipping Transfer Tax. It's too complicated and creates more problems than it was supposed to solve. No one understands it and the GST tax is highly "confiscatory," even more so than the estate tax. It's actually a second 55 percent estate tax on transfers over $1,030,000, basically to grandchildren. Why isn't anyone upset about that? It should be repealed immediately and completely along with the Alternative Minimum Tax on individuals, which is another overly complicated tax that truly does affect many taxpayers who are not wealthy.

After that, if the government still had money to give back to us and wanted to reduce any more taxes, it should reduce personal income taxes, which are paid by most Americans. To me, that is fair tax reform. Any comments? I appreciate receiving your emails whether you agree or disagree. The debate makes this a better forum for all. Email me at: Slottcpa@aol.com